Debt and the Deficit

1
Deficits, Surpluses, and the National Debt
2

• Marriage License Tax
• Medicare Tax
• Personal Property Tax
• Property Tax
• Real Estate Tax
• Service Charge Tax
• Social Security Tax
• Road Usage Tax
• Sales Tax
• Recreational Vehicle Tax
• School Tax
• State Income Tax
• State Unemployment Tax (SUTA)
• Telephone Federal Excise Tax
• Telephone Federal Universal Service Fee Tax
• Telephone Federal, State and Local Surcharge
  Taxes
• Telephone Minimum Usage Surcharge Tax

• Accounts Receivable Tax
• Building Permit Tax
• CDL license Tax
• Cigarette Tax
• Corporate Income Tax
• Dog License Tax
• Excise Taxes
• Federal Income Tax
• Federal Unemployment Tax (FUTA)
• Fishing License Tax
• Food License Tax
• Fuel Permit Tax
• Gasoline Tax (42 cents per gallon)
• Hunting License Tax
• Inheritance Tax
• Gross Receipts Tax
• Inventory Tax

• Tax his car,
• Tax his gas,
• Find other ways
• To tax his ass
• Tax all he has
• Then let him know
• That you won't be done
• Till he has no dough.
• When he screams and hollers,
• Then tax him some more,
• Tax him till
• He's good and sore.
• Then tax his coffin ,
• Tax his grave,
• Tax the sod in
• Which he's laid.
• Put these words

• Tax his land,
• Tax his bed,
• Tax the table
• At which he's fed.
• Tax his tractor,
• Tax his mule,
• Teach him taxes
• Are the rule.
• Tax his cow,
• Tax his goat,
• Tax his pants,
• Tax his coat.
• Tax his ties,
• Tax his shirt,
• Tax his work,
• Tax his dirt.

Taxes We Didnt Have 100 Years Ago
3
Chapter Objectives 1. Explain the
difference between the budget deficit and public
debt. 2. Explain each of the three budget
philosophies. A. Annually balanced budget
B. Cyclically balanced budget, and C.
Functional Finance 3. Identify the principal
causes of the public debt. A. Wartime
financing B. Fighting recessions
C. Tax cuts D. Lack of political will 4.
Describe the annual interest charges on the debt,
who holds the debt and the impact of
accounting and inflation on the debt. 5. State
the absolute size of the debt and the relative
size as a of GDP. 6. Explain why the debt can
also be considered public credit. 7. Identify and
explain two widely held myths about the public
debt. A. Going bankrupt B. Burden on our
grandchildren 8. Explain the effect of the debt
on income distribution and Ig. 9. Explain how the
debt higher interest rates might decrease net
exports. 10. Explain 3 proposed remedies to
reduce or to eliminate budget deficits.
Budget Deficits and the National Debt
And the concept of crowding-in
4
"Crowding Out" and "Crowding In"
5
Incr G incr I.R. Decr Ig
"Crowding-out" Effect
DI
10 8 6 4 2
Loanable Funds Market
PL
Real I.R.
s
D2
AS
D1
AD2
AD1
4 2
G
10
Real interest rate
Crowding Out Effect
6
IG
YR
Y
F2
F1
5 10 15 20 25
15
0
Quantity of LF
Investment (billions of dollars)
In this case, it would be 100 crowding out.
G can finance a deficit by 1. Borrowing - this
raises interest rates in the LFM and crowds
out investment. 2. Money Creation - no crowding
out so is more expansionary than borrowing.
Friedman Just follow the monetary rule.
6
THE CROWDING In EFFECT
DI2
16 14 12 10 8 6 4 2 0
AS
DI1
AD2
AD1
G
Y
YR
Real interest rate ()
5 10 15 20 25 30 35
40
Investment (billions of dollars)
But if the economy is operating well below its
potential, increased government spending could
result in more jobs, more positive profit
expectations, and a crowding in of Ig.
7
How Crowding In Might Work
Crowding In potential for G spending to
stimulate private investment in an otherwise
sluggish economy. Crowding Out represents
argument for passive fiscal policy. Crowding In
would be an argument for active fiscal policy.
If the economy is operating well below its
potential, the additional fiscal stimulus
provided by deficit spending could encourage
firms to invest more. A G deficit could
stimulate a weak economy, increasing AD putting
a sunny face on business expectations. As
business expectations grow more favorable, firms
could become more willing to invest. thus,
crowding in of investment
If you have ever approached a crowded
restaurant, you may not have wanted to put up
with the hassle of a long wait and were
thus crowded out. Similarly, large G deficits
may drive up interest rates and crowd out some
investment.
As Yoga Berra would say, No one goes
there any more. Its too crowded. Yoga also
said, If you come to a fork in the road, take
it.
On the other hand, did you ever pass up a
restaurant because the place seemed dead-it had
few customers. Perhaps you wondered why so few
people chose to eat there. With just a few more
customers, you might have been willing to crowd
in. Businesses may be reluctant to invest in a
lifeless economy. Economic stimulus could
encourage them to crowd in.
8

• Annually Balanced Budget
• Cyclically Balanced Budget
• Functional Finance

Three Budget Philosophies
9
A. Annually Balanced B. Cyclically
Balanced C. Functional Finance
Three Budget Philosophies
G
Economy
Earth Orbits Sun
Annually Balanced Budget each time the earth
orbits the sun we should balance the budget.
This would put the G in an economic straitjacket
as we couldnt fight recessions with deficit
spending. This would be like pouring water on a
drowning man. We used to worship at the alter of
a balanced budget prior to the Great Depression.
49 states require this. Balancing the budget
during a recession would not be counter-cyclical,
but pro-cyclical. Increasing taxes during a
recession would worsen the recession. Running a
surplus during boom times and giving the money
back would be inflationary.
10
Balancing the Budget during Recession Increase
T or Decrease G - Procyclical
AD1
Cut
AS
AD2
AD3
So, the fiscal actions to balance the
budget decreases, rather than increases AD, and
is procyclical, not counter.
PL1
PL2
PL3
YR
Y
YR
11
Balancing the Budget - during Inflation Decrease
T or Increase G - Procyclical
AS
AD3
AD2
AD1
PL3
PL2
So, the fiscal actions to balance the
budget increase, rather than decrease AD, is
also procyclical, rather than counter.
PL1
YI
Y
YI
12
Inflation Raise taxes
2. Cyclically Balanced Budget
Tax Cuts
Raise Taxes
Recession Tax cut
Balanced
Deficit Spending
Cyclically Balanced Budget run deficits during
recessions surpluses during expansions so the
budget is balanced not each year but over the
course of the business cycle. Economic wisdom
tells us we should have deficits in lean years
and surpluses in fat years. There is nothing
sacred about 12 months as an accounting period.
The government could conduct counter-cyclical
fiscal policy and balance its budget over a
period of years. The basic problem of this
philosophy is that fluctuations are not usually
symmetrical enough to ensure that the surplus
will offset the deficit.
13
3. Functional Finance
U.S. Economy
Balance the economy, not the budget.
Functional Finance balance the economy not the
budget. The annual or cyclically balanced budget
is of secondary importance. The important thing
is to provide for non-inflationary, FE ensure
the economy produces its potential GDP. If there
are chronic deficits or surpluses, so be
it. Deficits are minor problems, compared to
inflation or recessions.
14
The Debt and the Deficit
9.4 tril.
Flow (162 bil.)
Reasons for Debt 1. Lack of political will 2.
Tax cuts 3. Recessions (transfers) 4. Wartime
financing
Stock (9.4 trillion)
ADD Attention Deficit Disorder Congressmen
have trouble focusing attention on the deficit.
9.4
15
33,000
9.4 Trillion Debt
Per Capita
3
3,
9,
4
1 4 0,
The Debt is increasing by 1 million per
minute.
1.58 billion per day is being added to the debt.
16
The National Debt Since 1970
17
The Federal Budget Deficit
18
Sources of Government Revenue 1863
Yea! We dont have to pay any federal income or
SS taxes.
19
Sources of Government Revenue - 2006
We are paying about 1 trillion in taxes.
7 179 B
Three major sources of federal taxes(90) a.
Individual income taxes b. Social
Insurance c. Corporate income taxes
37 884 bil.
11 261 B
45 1,096
Deficit 248 bil.
20
2008 Federal Budget Proposal-2.9 Tril.
Agriculture 90.9 Interest 243 Commerce
6.7 Defense
527.6 Education, job train. 62.6 Energy,
Environment 21.6 Health/Human SVC
699.0 Homeland Security 34.6 Housing/Urban
Dev. 36.2 Interior 10.1 Justice, Law
enforce 23.3 Labor 50.4 NASA 17.3 SEC
Exchange Com. 8.5 Corp Engineers
4.8 State 37.4 Social Security
655.5 Transportation 67.3 Legislative
Branch 4.8 Treasury 525.5 Judiciary
6.7 Veterans Affairs 84.4 Other
agencies 148.7
67.3
21
Federal Spending in 2007, by Function
22
DEFICITS, SURPLUSES, AND DEBT

• Definitions
• Budget Deficit G gt T
• Budget Surplus T gt G
• National or Public Debt

• U.S. Securities

23
1. Progressive2. Proportional3. Regressive
Three Types of Taxes
24
Flat Tax on Income same of income, different
amounts, so Proportional Flat Tax on Products
same amount, different of income, so Regressive
35
33
28
Marginal Tax Rates
Progressive takes a larger from high income
groups
25
15
10
Single - no tax on 1st 7,825
I only have to pay the FICA tax.
28
25
10
15
33
35
78,850
357,700
7,825
32,550
164,550
357,700
0
Standard Deduction 5,350-dependent
15,650-married filing jointly
11,200-HH
7,825-single
25
Our Progressive Tax System Is Like A Layered Cake
35 over 357,700
33 up to 357,700
28 up to 164,550
25 up to 78,850
15 up to 29,700
10 up to 16,050
No tax on 1st 7,825
26
Proportional Regressive Taxes
Proportional takes same 20 not amount from
all income groups
20
Example Medicare 1.45 on all income earned.
100,000
50,000
40,000
30,000
Pay 20,000
Pay 10,000
So, not same amount but same , 20
Take that, you low incomer.
30
Regressive takes a larger from low income
groups
20
Example Sales Tax
Im a low incomer.
10
40,000
50,000
30,000
27
What kind of taxes are these?
Flat Tax on Income same of income, different
amounts, so proportional. Flat Tax on Product
same amount, different of income, so
regressive.

• Toll Road(1 per day)
• 10,000 50,000
• 200 200
• 2 .4

Flat Tax on Cigarettes Excise1.41 cents
pack 1 pack day 1 pack day 10,000
100,000 515 515 5 .5

Addicted
State 6.25 Excise Tax on Two Identical 20,000
Autos BO MO
10,000 100,000 1,250 1,250
12.5 1.25
28

• Property Tax of 2.5 on 100,000 Houses
• 25,000 50,000
• 100,000 house 100,000
  house
• 2,500 2,500
• 10 5

What kind of taxes are these?
Flat Tax on Income same of income, different
amounts, so Proportional Flat Tax on Products
same amount, different of income, so Regressive
100 Spent On The Lottery 20,000
100,000 100 Lottery 100 Lottery
5 .1 The lottery tax
is a voluntary regressive tax on morons. What
about the .20 a gallon gasoline tax? So all of
these taxes were regressive.
I played the lottery.
29
TAX RATE TAX RATE State
(Cents per pack) Rank State
(Cents per pack) Rank Alabama(1)
16.5 47 Nebraska 64 24 Alaska 200
4 Nevada 35 39 Arizona 200 4 New
Hampshire 52 32 Arkansas(20) 59 26 New Jersey
258 1 California 87 19 New
Mexico 91 18 Colorado 20 43 New York (1)
150 5 Connecticut 200 3 North
Carolina 30 45 Delaware (3) 24 41 North
Dakota 44 34 Florida
33.9 40 Ohio 55 29 Georgia
37 36 Oklahoma 23 42 Hawaii (30 130
7 Oregon 128 8 Idaho
57 27 Pennsylvania 100 12 Illinois (1)
98 17 Rhode Island 246 2 Indiana
55.5 28 South Carolina 7 51 Iowa
36 37 South Dakota 53 31 Kansas
29 20 Tennessee (1)(2) 20 48 Kentucky (2)
30 46 Texas 141 11 Louisiana
36 37 Utah 69.5 23 Maine 200 3 Ve
rmont 119 10 Maryland 100 12 Virg
inia (1) 30 47 Massachusetts 151
4 Washington 203 3 Michigan 200
5 West Virginia 55 29 Minnesota
48 33 Wisconsin 77 21 Mississippi
18 49 Wyoming 60 25 Missouri (1) 17 50 Dist.
Of Columbia 100 12 Montana 170 6 U.S.
Median 90
State Excise Tax on Cigarettes
Counties cities may impose an additional tax on
a pack of cigarettes. Also, the federal tax is 39
cents. NYC has an additional 1.50 for a total
cigarette pack price of 7.50. 30 states have
increased cigarette taxes since January 1, 2002
some twice. Every 10 increase reduces youth
smoking by 7 and adult smoking by 2.
30
If you inherit 2 million dollars this year, how
much do you get to keep?
The Estate Tax
31
Estate Tax taxes on inheritances
The Federal Estate Tax is disappearing. An estate
is exempt from federal estate taxes if its below
the following thresholds. The Tax will disappear
in 2010, only to reappear in 2011. tax of 55
on estates after the first million
2 M tax free
2007
2 M tax free
2008
3.5 M tax free
2009
2010
No estate tax
2011
1 M tax free
If you live in one of the gold states, you
might owe additional estate or inheritance
taxes, even after the federal Gs death
tax disappears.
32
2006
Expenditures of 2.654
Revenues of 2.407
Deficit of 248
Last Surplus
33
Causes of the National Debt
Facts Figures
Financial Price Of War Total Cost
per Conflict Cost Person WW1 125 bil.
2,489 WWII 600 bil. 20,388 Korea 336
bil. 2,266 Vietnam 494 bil. 2,204 Gulf War
I 76 bil. 306 Gulf War II 438 bil.
536 Cost over 12 billion a month
Causes

• Wars
• Recessions
• Tax Cuts

• No political will

300,000 from the Afghanistan-Iraq wars suffer
from PTSD Post-Traumatic Stress Disorder or
major depression that will cause the nation over
6 billion over two years.
The War in Iraq has cost 16,000 per family.
34
Historical Record of the Marginal Tax Rate
91 on income over 200,000
91
35
2008
35
Medicare tax 1.45 for an individual 2.9 for
self employed for every dollar earned. Harrison
Ford received 25 million for 20 days work on
a movie. 1.45 of 25 million 362,500 x 2
725,000 medicare tax. Over his 35 years on
the Big Screen, his films grossed over 10
bil. Jim Carrey gets 20 million per movie,
so his tax is 580,000. 1.45 of 20 million
290,000 x 2 580,000.
Top Marginal Tax Rates Year Tax Rate 1900
No Tax 1914 1 over 3,000 Only 1 in 270 paid
this tax at all 1930 30 1 in every 32
was now paying taxes 1940 81 1 in every
3 was paying taxes 1943 Paycheck withholding
(by the boss) was launched to stop cheating. 1950
over 200,000 91 1970
70 Everyone was paying with taxable Y 1980
70 2000 39.6 2008 35
Marginal Tax Rate 1913-2008
91 for dollars over 200,000
36
Government Finance
Total Tax Revenue Selected Nations Percent of
Total Output-2004
10 20 30 40 50
Sweden Denmark Norway Finland France Italy United
Kingdom Germany Canada Australia United
States Japan South Korea
50.7
49.6
44.9
44.3
43.7
42.2
36.1
34.6
33.0
31.6
25.4
25.3
24.6
Source Organization for Economic Cooperation and
Development
37
Percent Federal Income Tax Paid by Different
Income Percentiles
100 90 80 70 60 40 30 20 10
97
134 million filed tax returns but only 90 million
paid any taxes. Our average tax rate was 14.
85
68
57
61,000 and over
30,000 and over
37
99,000 and over
137,000
328 000
3.3
Bottom 5
Top 25
Top 50
Top 1
Top 5
Top 10
38
Let's Demonstrate Our Tax System In The Real World

• Suppose that every day, ten men go out for beer
  and the bill for all ten comes
• to 100. If they paid their bill the way we pay
  our taxes, it would go like this
• The first four men (the poorest) would pay
  nothing.
• The fifth would pay 1.
• The sixth would pay 3.
• The seventh would pay 7.
• The eighth would pay 12.
• The ninth would pay 18.
• The tenth man (the richest) would pay 59.

• So, that's what they decided to do. The ten men
  drank in the bar every day and
• seemed quite happy with the arrangement, until
  one day, the owner threw them
• a curve. 'Since you are all such good customers,
  he said, 'I'm going to reduce
• the cost of your daily beer by 20. Drinks for
  the ten now cost just 80.

The group still wanted to pay their bill the way
we pay our taxes so the first four men were
unaffected. They would still drink for free. But
what about the other six men - the paying
customers? How could they divide the 20
windfall so that everyone would get his 'fair
share?'
They realized that 20 divided by six is 3.33.
But if they subtracted that from everybody's
share, then the fifth man and the sixth man would
each end up being paid to drink his beer.
39

• So, the bar owner suggested that it would be fair
  to reduce each man's bill by roughly the
• same amount, and he proceeded to work out the
  amounts each should pay.!  And soThe fifth man,
  like the first four, now paid nothing (100
  savings).
• The sixth now paid 2 instead of 3 (33savings).
  
• The seventh now pay 5 instead of 7
  (28savings).
• The eighth now paid 9 instead of 12 (25
  savings)
• The ninth now paid 14 instead of 18 (22
  savings)
• The tenth now paid 49 instead of 59 (16
  savings).
• Each of the 6 was better off than before. And the
  first 4 continued to drink for free.
• But once outside the restaurant, the men began to
  compare their savings.'I only got a dollar out
  of the 20,'declared the sixth man. He pointed to
  the tenth
• man,' but he got 10!
• 'Yeah, that's right,' exclaimed the fifth man. 'I
  only saved a dollar, too. It's unfair that
• he got ten times more than I!
• 'That's true!!' shouted the 7th man. 'Why should
  he get 10 back when I got only two?
• The wealthy get all the breaks!''Wait a minute,'
  yelled the first four men in unison. 'We
• didn't get anything. The system exploits the
  poor!'The nine men surrounded the tenth and beat
  him up.
• The next night the tenth man didn't show up for
  drinks, so the nine sat down and had
• beers without him. When it was time to pay the
  bill, they discovered something important.
• They didn't have enough money between all of them
  for even half of the bill!And that is how our
  tax system works.
• The people who pay the highest taxes get the most
  benefit from a tax reduction. Tax them

40
STATE AND LOCAL FINANCE
State Expenditures
Education
Public Welfare
Health and Hospitals
Highways .20 a gallon
Public Safety
Education 36
Health Hospitals 8
Public Welfare 25
Highways 8
All Other 18
Public Safety 5
41
Federal Expenditures
Pensions and Income Security National
Defense Health Interest on Public Debt
Pensions Income Security 35
Total Expenditures 2,654 Billion
National Defense 20
All Other 15
Health 21
Interest 10
2006 Data
42
Federal Tax Revenues
Personal Income Tax Payroll Tax Corporate Income
Taxes Excise Taxes
Total Tax Revenues 2,407 billion
Personal Income Tax 46
Excise Taxes 4
Payroll Taxes 38
All Other 4
Corporate Income Tax 8
2006 Data
43
STATE AND LOCAL FINANCE
State Revenues
Sales and Excise Tax
Personal Income Tax
Corporate Income Tax
Licenses and Others
Property Taxes Other Taxes
Sales Excise Taxes 48
State Personal Income Tax 34
Property Taxes Other Taxes 5
Corporate Income Tax 7
Licenses Others 6
44
States with No Income Tax (Red)
They tend to have more regressive tax systems.
45
State, City, and County Sales Tax
46
State Sales Tax
47
STATE AND LOCAL FINANCE
Local Revenues
Property Taxes
Sales and Excise Taxes
Personal Corporate Income Taxes
Property Taxes 74
Sales Excise Taxes 16
Personal Corporate Income Taxes 6
All Other 4
48
National Debt History
9.4 Tril.
49
National Debt Historyadjusted for inflation in
2000 dollars
9.4 Tril.
Except for WWII, the deficit stayed pretty
constant for about 40 years until 1983
50
Who Owns Most of the National Debt?
51
PUBLIC DEBT OWNERSHIP, 2006 This is held both
privately and publicly
Other, Including State Local Governments
U.S. Banks Financial Institutions
Federal Reserve
49
U.S. Government Agencies
Debt held outside the Federal Gov and Fed 49
8
9
8
Foreigners hold 1.9 Trillion Japan-582 B,
China-500 B, Britain-266 B, OPEC-126 B, S.
Korea-46 B, H. Kong56 B, Taiwan-53 B,
Singapore-24 B, Thailand-13 B, India-13
B. World Total 2,247
42
25
8
Foreign Ownership
51
Debt held by the Fed Gov. Agencies 51
U.S. Individuals
52
Economic Implications of the Debt False
Issues The G doesnt have to pay the entire
debt off because it never dies. The G will
live forever so it will keep rolling it over in
perpetuity
Whew! 33,000 each.
Im not paying no 33,000.
Going Bankrupt?
The no answer entails three points. 1.
Refinancing as portions of the debt fall
due each month, the G does not cut G or raise
T to retire the maturing bonds. It refinances
the debt by selling new bonds and uses the
proceeds to pay off holders of the maturing
bonds. 2. Taxation if bankruptcy were imminent
the G could always raise taxes. 3. Creating Money
bankruptcy could be avoided by printing the
money (inflationary).
Shifting
Burdens Does every new born get slapped on the
backside, then told he owes 33,000? Not quite.
About 82 of the debt is owed to ourselves.
Thus the public debt is a a public credit.
It is a liability to the taxpayer but an asset to
the people (bondholders). Therefore, retiring
the debt would amount to a large transfer payment
from U.S. citizens to U.S. citizens. The
repayment would entail no decrease in the
economys wealth or standard of living. So the
babies who inherit 33,000 worth of debt
will inherit almost that same amount.
53
OPTIONS FOR THE SURPLUSES

• Pay Down the Public Debt
• Reduce Taxes
• Increase Government Spending
• Bolster Social Security Trust Fund
• Combination of these Policies

54
Can a budget deficit worsen a trade deficit?
55
Crowding-out effect in an Open Economy Xn are
crowded-out, decreasing AD
3. Decline in domestic inv. (crowding-out)
7. U.S. Exports decrease
1. Federal Government deficits
2. High real U.S. interest rates
6. Increased international value of dollar
10.Trade deficits
4. Increased foreign demand for U.S. bonds
8. U.S. Imports increase
9. Decrease in Xn decr AD
5. Increased U.S. external debt
56
Do we get any benefit from the large National
Debt?
57
One Good Thing Has Come From the National Debt
Now we tell them, You owe 33,000. (as
their share of the National Debt)
We no longer have to hit our newborn to get
their first cry.
Take That!
We get the same result their first cry no
more of that Take that.
The Debt prevents me from having to do this.
This is the way we used to get the first
cry out of a baby.
58
Debt and Deficit NS 1-6

• 1. The (national debt/federal budget deficit)
  consists of the
• accumulation of all Federal government
  deficits surpluses.
• 2. The (national debt/budget deficit) is found by
  subtracting
• G tax revenues from government spending in
  one year.
• 3. How much is the National Debt now? _________
• 4. If G adhered strictly to an annually
  balanced budget, Gs
• budget would tend to (stabilize/destabilize)
  the economy.
• 5. The idea of increasing T during good times
  decreasing
• them during bad times recessions over the
  course of
• the business cycle, the budget would be
  balanced is the
• (annually/cyclical) balanced budget.
• 6. The philosophy of functional finance is the
  idea that the
• main function of the budget is to
  (stabilize/destabilize) the
• economy balancing the budget every year is
  of
• (little/extreme) importance.

9.4 trillion
59
Debt and Deficit NS 7-11

• 7. Budget deficits were smaller during the
• (1970s/1980s early 1990s)
• 8. Between 1980 1996 the public debt (grew/did
  not grow) absolutely and as a percentage of GDP.
• 9. The largest proportion of the public debt is
  held by (foreigners/American public). Therefore
  we (can/can not) say the public debt is a public
  credit.
• 10. The crowding-out effect suggests that
  increases in G spending financed thru borrowing
  will (increase/decrease) the interest rate and
  (increase/decrease) private investment.
• 11. The most likely way the public debt imposes a
  burden on future generations is by reducing the
  current level of (employment/capital
  accumulation), thus giving us a smaller national
  factory.

60
Debt and Deficit NS 12-14

• 12. Large budget deficits (increase/decrease)
  domestic interest rates, (increase/decrease) the
  international value of the dollar, and
  (increase/decrease) American net exports which
  (enhance/diminishes) expansionary fiscal policy.
• 13. The line-item veto would have permitted the
  president to (add/delete) individual projects and
  programs from larger appropriation bills.
• 14. The (GDP/GNP/GRH) was a program designed to
  balance the budget.

61
Review for Last Test
besides Final Exam

• Money, Banking, Money Creation, Monetary
  Policy, Extending AS, Macro Disputes, Debt and
  Deficit

62
Test Review 1-4
1. What is the monetary rule? 2. If a household
spends 100,000 per year, on average holds a
money balance of 20,000, their velocity of
money is ____.
Increase the MS 3-5 a year
5
AS2
LRAS
3. An unanticipated increase in PL will lead to
(lower/higher) product prices, (decr/incr)
in profits a(an) (decr/incr) in unemp. in SR.
AS1
b1
a2
AD1
PL28
Higher PL results in higher nominal wages
shifts SRAS left.
AD2
a1
PL13
Output employment increased in the SR but
not the LR.
4. With the unanticipated increase in PL -
output employment did (incr/decr) in the SR
but (decreased/increased/ stayed the same) in the
LR.
Inflat. Gap
o
Y1
Y2
63
Test Review 5-7
5. The two main variants of the natural rate
hypothesis are (RATEX/Keynesian/Adaptive
Expectations/Reaganomics). 6. According to
the Monetarists, the investment demand curve
is more (flat/vertical) and the money demand
curve is more (flat/vertical). 7. Does the
economy self-correct if prices are flexible
but wages are not? _______
Keynesian cause-effect chain
Monetarist cause-effect chain
no
64
8. An unanticipated increase in AD would result
in output (incr/decr/stay same) in SR, but
(incr/decr/stay same) in LR. 9. An anticipated
increase in AD would result in Y
(incr/decr/ stay the same) in the SR and
(incr/decr/stay the same) in the LR.
LRAS
SRAS2
AD1
SRAS1
E3
E2
Price Level
PL26
PL13
E1
AD2
Inflati. Gap
Y employment increased in the SR but not
the LR.
o
Y1
Y2
RDO
65
T.R. 10-11
Review of SRAS LRAS
Lower PL reduces nominal wages shifts SRAS
right.
10. In the LR, a decline in inflation will
(incr/decr/not affect) output employment.
LRAS
AS1
AD1
AS3
Y employment decreased in the SR but not
the LR.
a1
PL13
AD2
PL21
a3
c1
Recess. Gap
0
YR
Y
11. If decline in inflation is anticipated,
Y/empl. will (increase/decrease/not change) in
SR. or LR
Real domestic output
66
Test Review 12-18

• 12. An annually balanced budget is pro-cyclical
  because tax revenue reductions associated with
  recession will require (increases/decreases) in G
  spending or increases in taxes.
• 13. Proper monetary policy during inflation is
  (raise, raise, sell/ lower, lower, buy) Discount
  Rate, RR, bonds.
• 14. An increase in the MS will lead to a(an)
  (increase/decrease)
• in the interest rate (decrease/increase)
  AD.
• 15. Crowding out is something the
  Keynesians/Monetarists) believe strongly in.
• 16. Selling bonds by the Fed would result in a
  (smaller/larger) MS and (lower/higher) interest
  rates.
• 17. If you are estimating your expenses for the
  prom at 800, then you are using money as (unit
  of account/medium exchange/store of value).
• 18. Foreign individuals and governments (hold/do
  not hold) most of the Public Debt.

67
Test Review 19-24

• 19. Fiscal policy is thought to work best at
  fighting (inflation/
• depressions) and monetary policy is thought
  to work best
• at fighting (inflations/depressions).
• 20. The Laffer curve was a cornerstone of
• (RATEX/Supply-side/ Keynesians) economics.
• 21. The tight money cause-effect chain is
  (incr/decr) the MS, which would (incr/dec) the
  interest rate, which would (incr/decr) Ig, which
  would (incr/decr) AD and GDP.
• 22. The easy money cause-effect chain is
  (incr/decr) the MS, which would (incr/decr) the
  interest rate, which would (incr/decr) Ig, which
  would (incr/decr) AD and GDP
• 23. The (Monetarists/New Keynesians) are
  advocates of monetary and fiscal policy.
• 24. An easy money policy will cause the dollar to
  (apprec/deprec) and cause American Xn to
  (incr/decr).

68
Test Review 25-33

• 25. A tight money policy will cause the dollar to
  (apprec/deprec) and cause American net exports to
  (increase/decrease).
• 26. A bank loan from the Fed will
  (increase/decrease/not affect) RR, but
  (increase/decrease/not affect) ER and therefore
  TR.
• 27. A bank deposit by the public will
  (increase/decrease) RR,ER, TR.
• 28. RATEX are strong advocates that the publics
  expectations
• (strongly influence/negate) fiscal and
  monetary policy.
• 29. The intellectual roots of monetarism are
  based on (Classical/Keynesian) economics.
• 30. An adherence with an annually balanced budget
  would (stabilize/destabilize) the economy.
• 31. If there is a decrease in AD and prices are
  not flexible, the resulting recession will be
  worse because equilibrium price level will be
  (lower/higher) than with flexible prices.
• 32.In the SRPC, there (is a/is no) tradeoff
  between inflation output, and in the LRPC there
  (is a/is no) tradeoff between inflation and
  unemployment.
• 33. The (SRPC/LRPC) is consistent with the stable
  traditional Phillips curve.

69
Extra Practice MS Currency DD of PUBLIC
RR is 25 Assets
DD(Liabilities)
TRRRER100 mil. 400 million 1. How much
can this bank loan out? ______ 2. If Christina
A. puts _________ in this bank(DD), ER will
increase by _______. 3. Possible Money
Creation in the system could be ________. 4.
Potential Total Money Supply could be as much as
_________.
0
10,000
7,500
30,000
40,000
70
Extra Practice MS Currency DD of
PUBLIC
RR is 25 Assets DD
(Liabilities) TRRRER 100
mil. 400 million 5. How much can Christinas
bank loan out? ______ 6. If Christinas Bank
borrows 10,000 from the Fed ER will
increase by _______. 7. Possible Money
Creation in the system could be _________. 8.
Potential Total Money Supply could be as much as
__________.
0
10,000
Christinas Bank
Fed
40,000
40,000
71
Test Review 34-38 Money Creation Questions
34. If the RR is 50 and the Fed buys 100 M of
bonds from the PUBLIC Kate, then the MS is
increased by _______. ER are increased by
______. PMC is _______. TMS would be ______. 35.
RR is 40 and the Collins Bank borrows 100 M
from the Fed. As a result, RR are increased by
______. ER is increased by _______. PMC and
TMS is increased by ________. 36. Your bank has
DD of 200,000 and the RR is 50. If RR and
ER are equal, then TR are _______. 37. The Buzon
Bank has ER of 75,000 DD is 100,000. If the
RR is 20, TR are _________. 38. RR is 10 the
Fed buys 10 million of bonds from the PUBLIC
Mary. The MS is increased by _______. ER are
increased by _______. PMC is _______. TMS
would be _________.
100 M
100 M
200 M
50 M
0
250 M
100 M
200,000
95,000
10 M
90 M
100 M
9 M
Banks PUBLIC Fed
72
Additional Practice on Money Creation
1. If the RR is 40 and the Fed buys 100 M of
bonds from the PUBLIC Ann, then the MS is
increased by _______. ER are increased by
______. PMC is _______. TMS would be ______. 2.
RR is 50 and the Boase Bank borrows 100 M from
the Fed. As a result, RR are increased by
______. ER is increased by _______. PMC and
TMS is increased by ________. 3. Your bank has DD
of 400,000 and the RR is 25. If RR and ER
are equal, then TR are _______. 4. The Palmer
Bank has ER of 60,000 DD is 200,000. If the
RR is 20, TR are _________. 5. RR is 20 the
Fed buys 50 million of bonds from the PUBLIC
Marie. The MS is increased by _______. ER are
increased by _______. PMC is _______. TMS
would be _________.
100 M
150 M
250 M
60 M
0
100 M
200 M
200,000
100,000
50 M
200 M
250 M
40 M
Banks PUBLIC Fed
73
Money Creation Formulas
MS Currency DD of public
RR ER TR TR - RR ER TR - ER RR
Public
Public Student deposits 1.00 in a bank 1. ER
DD-RR x MM PMC 2. PMC 1st DD TMS
Fed

• No Public Fed gives 1.00 loan to a bank
• ER x MM PMC TMS